An introduction to the tax system for the self employed

Stringer Mallard can advise self employed people in the Harrogate area on all aspects of tax – here is an overview of some of the main things to consider.

Registering with HM Revenue & Customs (HMRC)

If you start working for yourself, you must register with HMRC by 5 October following the end of the tax year in which your self employment starts. Otherwise you may be liable to penalty based on the tax due to HMRC.

Post – download and complete form CWF1 or use the form incorporated in leaflet SE1 (Are you thinking of working for yourself?)

Once you become self-employed, the tax rules are quite different from those that may have applied when you were an employee. Instead of tax (and national insurance) being deducted from your earnings at source, you must be prepared to receive a bill at some time in the future. This can be a nasty shock if you haven’t put enough money aside.

We aim to give you as much warning as possible of the likely timing and amount of tax payments, but it is not easy to do this during the first year of your new business, or if you do not keep your records up-to-date.

What profits do HMRC tax?

The starting point for the calculation of taxable profits is your profit and loss account. In calculating taxable profits you are entitled to claim deductions from your business income in respect of any expenses incurred for the purposes of trade (with a few minor exceptions).

When you buy equipment for your business, you will be entitled to deduct the full cost (up to a maximum of £1 million per year). For most cars, you can deduct only a proportion of the cost for each year you own them and use them in the business.

If you take stock for your own use, the disposal should be shown in the accounts at market value, and not at original cost. It may be possible to avoid this by arguing that such items never actually formed part of your stock and showing the original purchase as private expenditure (drawings).

Tax is payable on the whole of the profits of a trade, and so payments for your own ‘wages’ (drawings) are not deductible. However, if your spouse works in the business, the wages are an allowable deduction, provided they are actually paid and are a reasonable reward for what is done.

How does HMRC allocate profit to tax years?

The aim of the system is that over the lifetime of your business the profits will be taxed in full, once, and once only. But to make the system fair, there are certain complications you will have to cope with.

The general rule is that the tax for a particular tax year is based on the profits of the twelve months to your accounting date in that tax year. For example, the tax for 2019/20 could be based on accounts for a year ending on various dates ranging from 6 April 2019 to 5 April 2020. This demonstrates that you get more time for the tax to be worked out if your accounts end early in the tax year, which is why 30 April is such a popular year-end for self-employed people.

How is the tax collected?

Tax returns

Tax returns covering income for the year ending 5 April 2019 have to be submitted to HMRC by the ‘filing date’ which is 31 October 2019 for paper returns and 31 January 2020 for online returns. The return will include a self assessment of your liability to income tax and capital gains tax.

There are automatic penalties for late filing of tax returns.

Payment of tax

Payments on account of income tax and Class 4 national insurance contributions (NICs) will be due on 31 January 2019 and 31 July 2019. These interim payments will be based on one half of the total liability (less any tax deducted at source) for 2017/18. You will have the right to reduce payments on account if you believe the income tax for 2018-19 will be lower.

The balance of income tax for 2018-19 is due on 31 January 2020 (along with the first payment on account for 2019-20 and any capital gains tax for 2018/19).

Interest and penalties will be levied for late payment.

What about the complications?

Opening years

In the first tax year of your business, the tax payable is based on the profit arising between the starting date and the following 5 April. This is taken as the appropriate fraction of the profit shown in your first set of accounts. Say you start on 1 June 2018 and your first accounts run to 30 June 2019 with a profit of £13,000, then tax will be worked out (to the nearest month) on the profits of the following periods:

2018/19

1 June 2018 to 5 April 2019 – 10/13 x £13,000 i.e. £10,000

2019/20

1 July 2018 to 30 June 2019 – 12/13 x £13,000 i.e. £12,000

You can see that the profit from 1 July 2018 to 5 April 2019 (9 months) has been taxed twice. The ‘overlap’ profit of £9,000 will be available for deduction when the business comes to an end, or (at least in part) if you change your accounting date to one nearer 5 April.

Change of accounting date

If you decide to change your accounting date from 30 June 2020 to 31 December 2020, and the accounts for the 18 months ending 31 December 2020 show a profit of £27,000, the taxable profit for 2020/21 will be worked out as follows:

Profit based on accounts (18 months)

£27,000

Less overlap relief

£6,000

Profit for 2020/21

£21,000

Cessation

If you then cease trading on 31 August 2022, and your final accounts for the eight months ending on that date show a profit of £11,000, the taxable profit for 2022/23 will be:

Profit since accounting date in previous tax year

£11,000

Less balance of overlap relief not already used

£3,000

Profit for 2022/23

£8,000

What about national insurance?

The self-employed are subject to a two-tier system of national insurance contributions (NICs). Class 2 NICs are at a flat rate of £3.00 per week, if earnings exceed £6,365 per annum.

Payments for self-employed Class 2 NICs are due on 31 January following the end of the tax year.

Profits between £8,632 and £50,000 are subject to Class 4 NICs at a rate of 9%. Any excess of profit above £50,000 is subject to Class 4 NICs at the rate of 2%, without any upper limit. Class 4 NICs are collected by HMRC and are payable at the same time as the instalments of income tax.

Save for your tax

It is essential that you make proper provision to ensure the availability of funds to pay income tax and Class 4 national insurance. Interest on unpaid tax is chargeable by HMRC, and is not deductible from business profits.

Please call us if you would like further help or advice on this matter.

Cash basis for small businesses

In order to try and simplify the calculation of taxable income for small businesses, HMRC introduced an optional alternative system for eligible unincorporated businesses. Such businesses may calculate taxable income figures on a simpler cash basis if this suits the business. They will not have to compile figures of debtors, creditors and stock, or distinguish between ‘capital’ and ‘revenue’ expenditure and will not have to compute capital allowances to arrive at taxable income.

A second measure allows all unincorporated businesses to choose to use flat rate expenses for particular items of business expenditure.

If you are self-employed in the Harrogate area and would like advice on tax or any other business issue, contact Stringer Mallard.

What our clients say

“ I use Stringer Mallard for several of my businesses and have found them to be a friendly, supportive and professional team that are happy to help.

The combined knowledge and experience within the team mean that my queries are always answered and I feel confident in the answers that they give. The services that they provide are tailored to me and my businesses rather than a ‘one size fits all’ approach. I have found them to be flexible and willing to work with me, providing valuable insights into my business. ”

Jason Clay - Director - Quarters Developments Ltd

“ I have used Stringer Mallard for many years and they have provided an outstanding quality service tailored to my business requirements. I would highly recommend them to anyone looking for an accountant who can explain things in plain English. I can discuss all my business matters with them and find their advice most helpful. They have played a leading role in the evolution of my businesses over the last few years. ”

Paul Walker - Managing Director - Auto VIP

“ We have used the services of Stringer Mallard for many years within our training business and have always found the service to be excellent! Stringer Mallard’s approach is extremely entrepreneurial and we have found their business advice to be invaluable. I would have no hesitation in recommending Stringer Mallard’s services and have indeed done so to many of my associates and friends. ”

Paul Hughes - Director - Hughes Training Solutions Ltd

“ We have been with Stringer Mallard for several years and they have a great team who have dealt with our financial affairs efficiently and professionally, whilst being very friendly and approachable. Andrew is always available to discuss our business and is a valuable source of impartial advice. ”

“ Working in the Financial Services arena ourselves, we need an Accountancy practice that not only understand the technical and legislative side of our industry but also appreciate the importance of the personal service side and building a relationship based on trust and sound advice. Stringer Mallard are able to provide all of this and at a price that is very competitive with the big high street firms! It’s a cliché but they really are big enough to cope but small enough to care. ”

Kirk James - Director - Lofthouse Gate

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Nigel Coughlan - Director - COW Hold Ltd

“ I moved to Stringer Mallard several years ago, when I faced a challenging situation in my retail business. I found Andrew Stringer to have a level headed and optimistic and enthusiastic approach to my particular problem. He was connected well enough to arrange meetings that led to me being able to get back on track with renewed confidence. With a plan, support from a new bank and with Andrew’s very personal support to myself and my business, I was able to drive the business forward, which has since tripled in turnover and quadrupled in net profits. This in turn however attracted bigger tax liabilities. Stringer Mallard have a tax planning specialism. I would only work with a company and a scheme that operates both within the law and one that has an in depth and thorough understanding of tax law. ”

Jeremy Beaumont - Rhodes-Wood Ltd

“ We have employed the services of Stringer Mallard since 2004, Andrew and his team have helped Clean And Tidy expand our business with their professional and direct approach to our accountancy requirements. They have advised us on all aspects of our business and helped us with ideas and how to grow our business. It is very valuable to have someone there who you can call at anytime and get the right advice or be pointed in the right direction. They make things happen. We highly recommend the services of Stringer Mallard. ”

C A Tolmie - Director - Clean and Tidy

“ Stringer Mallard have been our accountants in the UK for 15 years and during that time they have been an important factor in the growth of our business. Funville started from nothing eight years ago and has grown every year since. Our relationship is simple; if we have a problem or a strategic decision to make, we call them and they are involved from start to finish. Their advice and input is simply invaluable and of great importance to us. ”

Stringer Mallard, Harrogate Accountants

We recognise that being in business, especially leading a business, can be an isolating experience. We are your business partner for all the decisions you have to make, genuinely assisting in bringing to life your goals and ambitions.